Tax Wars

Nothing so neatly differentiates the presidential candidates as their views on taxes. George W. Bush offers a rather extreme version of what passes for "conservative" fiscal policy these days. This philosophy doesn't tout deficit spending per se, but holds that low taxes, particularly on the wealthy, are the Holy Grail. Many who support this approach hope to starve the government of revenues and eventually shrink public spending. Republican antitax activist Grover Norquist summarizes this position when he argues that "a small government with a big deficit is a lot better than a big government with no deficit."

But others in the antitax camp, epitomized by former Representative Jack Kemp, offer the opposite theory. They believe that through the miracle of supply-side economics, tax cuts will so stimulate economic growth that revenues will go up and we will maintain or even expand government programs. Oddly enough, it's not uncommon to hear both conflicting views expressed simultaneously. Bush himself frequently rails against "big government," but also talks about the "additional revenues" his tax cuts could produce.

Unlike Bush, Al Gore is no borrow-and-spend supply-sider. In fact, he knows that if he is elected, it will be largely due to how well the economy and the federal budget have done since Bill Clinton's tax increases on the rich in 1993. But Gore's political ideology, based on the New Democrat theory that the truth is always somewhere in the middle, has led him to propose at least some tax cuts. Almost all of Gore's tax relief would go to middle-class and lower-income households. But in the details of his plan, Gore shows an unfortunate affection for using tax benefits as a substitute for direct government outlays (which are politically out of fashion). This both employs policy to micromanage people's lives and unnecessarily complicates the tax code.

As I've written in these pages, it's not clear to me that any substantial tax cut right now makes sense. The projected budget surpluses that are supposed to pay for the tax cuts aren't in hand yet; if and when they do materialize, they will be needed to meet future program obligations. And anyway, sticking with a prudent fiscal policy for the time being doesn't rule out tax cuts in the future, should things turn out better than expected. Indeed, paying down some of the national debt now can be the equivalent of a future tax cut since it frees up tax dollars otherwise devoted to interest payments.

Very Big Differences

There are two huge differences in the tax plans of the candidates. One has to do with the effect on the federal budget, the other with who gets the benefits. By a wide margin, it is the Republican who is less concerned about the fiscal health of the country.

Leaving aside Social Security and Medicare, the Congressional Budget Office (CBO) currently projects a total of $1.8 trillion in budget surpluses over the next 10 fiscal years. But that $1.8 trillion is based on admittedly unrealistic projections about future federal appropriations. CBO, by convention, assumes that these will merely keep up with inflation. If we note that appropriations will also have to grow with population and real wages to maintain the current level of public services, then about half of the supposed $1.8-trillion surplus disappears.

In fact, both candidates seem to understand that maintaining public services will require spending about $900 billion more than CBO officially projects. Gore has outlined how he would spend all of that and more--about $1 trillion--on things such as prescription drugs for seniors, education, children's health, national defense, and so forth. Bush, too, has an extensive list of spending plans for defense, education, health care, agriculture, housing, etcetera, that appear to cost upwards of $800 billion over the next decade. Once these plans are taken into account, the remaining 10-year surplus in everything but Social Security and Medicare is at most only about $900 billion (give or take $100 billion).

Which brings us back to the candidates' tax plans. Gore says that his proposed tax changes would cost close to $500 billion over 10 years, including added interest. If all goes well, Gore says his combined tax and spending proposals will allow him to devote about $300 billion from the general fund to reducing the national debt over the next decade. Bush, on the other hand, says his tax cuts over nine years (2002-2010) would cost $1.6 trillion--which leaves him at least $600 billion in the hole. And even this is optimistic since Bush has probably understated the cost of his tax package--by, among other things, leaving out its $340-billion cost in its 10th year. Not even the radical-conservative Republicans currently in charge of Congress have dared propose tax cuts as large as what Bush is promoting.

Bush's Social Security privatization plan also poses a major threat to our nation's fiscal health. Diverting 2 percentage points of the Social Security payroll tax to private investment accounts, as Bush proposes, means that Social Security taxes will immediately fall short of the amount needed to pay benefits--a shortfall that grows larger and larger as time goes by. Over its first decade, the Bush proposal could take $1 trillion in payroll taxes away from Social Security, plus about $300 billion in lost interest. Not wanting to be accused of harboring a plan to reduce benefits, Bush insists that he has "absolutely" no strategy for how to cover this enormous hole in the overall federal budget.

Who Gains?

The dramatic disparity in the size of the two candidates' tax programs is the most obvious reason to prefer one over the other. But the plans also differ sharply in whom they are designed to help the most.

By design most of the Bush tax cuts would go to upper-income taxpayers. In fact, a startling 43 percent of Bush's tax cuts would go to the best-off 1 percent. These fortunate few, whose average income was $915,000 in 1999, would get an average tax cut of $46,000 a year.

The centerpiece of Bush's tax-cut plan, reflecting about half its revenue cost when fully phased in, is a major reduction in personal income tax rates. Bush would lower the current top rates of 39.6 percent and 36 percent to 33 percent, and reduce the 31 percent and 28 percent rates to 25 percent. The current 15 percent bottom bracket would mostly be retained, but a new 10 percent bracket would be gradually phased in (by 2006 it would apply to a little under a quarter of the taxable income now taxed at 15 percent).

About a fourth of Bush's tax cuts would come from new or expanded tax credits and deductions. The $500-per-child tax credit would be doubled and extended to much higher-income families. Two-earner couples would eventually be able to deduct the lesser of $3,000 or 10 percent of the earnings of the lower-earning spouse. Taxpayers who don't itemize could deduct their charitable contributions in addition to their standard deduction. The rest of the Bush tax cuts reflect repeal of the federal wealth tax on very large estates (24 percent of the total tax cut) and tax breaks for corporations (2 percent of the total).

On the campaign trail, Bush frequently and falsely insists that his tax plan is "especially focused on low- and moderate-income families." At the same time, he is fond of pointing out that because the federal income tax is progressive, it's completely logical that well-off people get the bulk of his tax breaks. But the truth is that Bush carefully chose both the specific taxes he wants to cut--income taxes and the estate tax--and the way he wants to cut them in order to get a regressive result. Bush conveniently ignores the fact that for most Americans, payroll taxes and excise taxes loom much larger than income taxes. In terms of overall federal taxes, Bush's tax cuts range from a 5 percent reduction for the bottom fifth up to a 14 percent cut at the top.

While Bush would allocate most of his tax cuts to people making more than $100,000, almost all of Gore's tax cuts would go to people making less than that. Half the projected net cost of the Gore tax plan reflects a new kind of tax break for savings, which he calls Retirement Savings Plus. Individuals making up to $50,000 and couples making up to $100,000 would get a government match of up to 370 percent for money they put into special savings accounts to use for retirement, college, or first-time home purchases. These matching payments would be implemented through refundable tax credits, and their size would depend on income level, with the largest payments going to those who earn the least.

Gore proposes to increase the standard deduction for married couples to reduce or eliminate the "marriage penalty" for millions of families. (Almost all the benefits of this change would go to couples making less than $100,000.) Many working families (making up to $38,000) would see a boost in their Earned Income Tax Credit.

Gore has a variety of tax credits intended to help people in particular circumstances and at particular points in their lives. Workers lacking employer-paid health insurance could get a 25 percent refundable tax credit for purchasing coverage. Families making up to $60,000 with children in day care would get a major increase in the tax credit for dependent care expenses. The college tax credit enacted in 1997 would be boosted to a maximum of $2,800 (from $2,000) and made available at somewhat higher income levels. There would be a new tax credit of up to $3,000 for long-term care expenses.

Gore also proposes tax breaks for purchasing energy-efficient products. He would offset a collection of business tax breaks for various activities he favors by closing loopholes for things he disfavors. Finally, some of the overall cost of the tax cuts would be paid for with a 25-cent-per-pack increase in cigarette taxes and other tobacco levies.

The charts on pages 24 and 25 show who would benefit from the two candidates' plans. These charts are not exactly comparable. We can show precisely which income groups would benefit from the Bush program because it is built largely on changes in existing tax provisions. Gore's plan, by contrast, is mainly a set of novel tax credits. We don't know, by income group, just who would take advantage of these credits, but we can show the income ceilings, which demonstrate that nearly all of the benefit would go to people making less than $100,000 a year.

Courting Average Families

Despite the much smaller cost of Gore's tax plan, the two candidates aren't wildly divergent when it comes to the total tax cut dollars they target to all but the top income groups (where Bush sends most of his tax breaks). This has caused each candidate to compete with comically stylized examples to prove that his tax cut is better for average families.

According to Gore, every family has one kid in day care, another in college, and an ailing grandmother in a nursing home. They all take the standard deduction and can afford some long-term savings. According to Bush, nobody fits into these categories. Of course, the reality is that Gore's tax breaks will be bigger for some middle-income people while Bush's more generalized tax cuts will be bigger for others. At the lower end of the income scale, Gore almost certainly offers more because about two-thirds of his tax breaks are "refundable," making them available to taxpayers who don't owe income taxes (but generally do pay other taxes such as payroll taxes).

Although Gore's tax cuts can be praised for being clearly targeted to middle- and lower-income people, they do raise some troubling issues. Gore would extend the recent bipartisan trend of using tax policy to run what amounts to government programs. It's a well-known political gimmick that enables politicians to insist that we can cut taxes and increase spending. This approach is somewhat sickening to those of us who favor keeping the tax system as simple as possible and who worry about the IRS's ability to administer all these "incentives." Why should tax policy try to tell people how to run their lives? (Bush has raised exactly this last complaint, although his own tax plan has some similarly annoying provisions, albeit different ones of more benefit to the rich.)

Take, for example, Gore's biggest tax incentive program, Retirement Savings Plus. This is a new twist on the government's frequent, heretofore failed attempts to promote private savings through the tax code. It's nice that this time around the biggest incentives would at least theoretically go to those who presently can't afford to save anything. But is saving really the highest priority for those who already have trouble paying for food, clothing, and shelter? What happens to a family that is enticed to put some money into an RSP and then faces an emergency when it desperately needs the money? Will we just expand the list of approved withdrawals beyond college, home purchases, and retirement? The truth is that Retirement Savings Plus is a half-baked scheme. Nobody knows how many people would use these accounts, so nobody knows what they'll cost. And nobody knows whether they'll do more good than harm.

Some details of Gore's tax plan are fair game for criticism. But far more important are the candidates' big differences on overall tax and fiscal policy. On one side, we have a moderate Democrat offering something close to fiscal prudence and tax cuts limited to middle- and low-income Americans--albeit tarnished by far more complexity than necessary. On the other side, we have a Republican who wants to sound moderate but offers huge tax cuts targeted to the rich and an overall fiscal program that would undermine our economic and fiscal health. One hopes the public can tell the difference. ¤